State of Financial Crime 2023 Report

What Is FATCA Compliance?

Regulation Knowledge & Training

The Effects Of Foreign Account Tax Compliance Act On Foreign Accounts

The Foreign Account Tax Compliance Act (FATCA) is a federal law designed to counter tax evasion in the United States. Introduced in 2010, FATCA imposes a range of compliance obligations on both US and non-US financial institutions, including requirements for them to share information about their customers with the US government. FATCA

What is FATCA?

The Foreign Account Tax Compliance Act requires all US citizens to report to the Internal Revenue Service (IRS) any financial accounts they own that are located outside the United States. FATCA also requires foreign financial institutions to report details of accounts held by US customers and clients to the IRS. Accordingly, countries across the world have established intergovernmental agreements with the US government to impose FATCA compliance on financial institutions that operate within their jurisdiction.

What is the purpose of FATCA?

FATA was implemented to prevent American citizens from avoiding federal taxes by hiding their funds in offshore accounts. Designed to increase tax compliance, rather than to force foreign entities to collect tax revenues, FATCA is intended to address the legal requirement in the US that all American citizens living abroad must still pay US income tax. That requirement applies even if the income is generated in a foreign country and has no direct connection to the US. 

The US approach to foreign-generated income differs from almost all other developed countries, where citizens are allowed to pay tax in the location in which it was earned, under terms set out by double taxation treaties (DTT).

How does FATCA work?

FATCA comprises three key compliance provisions:

  • Foreign financial institutions: FATCA sets out a requirement for foreign financial institutions to enter into an agreement with the IRS. Under the terms of the agreement, those institutions must provide the IRS with information about accounts that are held by US citizens and their transactions. 
  • Reporting requirements: FATCA requires US citizens who hold foreign accounts to report their assets to the IRS using Form 8938
  • Swap-contract loophole: FATCA closes a tax loophole which previously allowed US citizens to avoid their tax liability by using swap contracts to convert US dividends to dividend equivalents. Under the terms of FATCA, the use of swap-contracts for this purpose is no longer possible.

What Must US Citizens Report Under Foreign Account Tax Compliance Act?

Under FATCA, US citizens must report all foreign assets. However, determining what assets qualify may be difficult. The IRS defines foreign assets as foreign-held: 

  • Financial accounts
  • Pensions
  • Life insurance products
  • Mutual funds
  • Hedge funds
  • Stockholdings
  • Partnership interests
  • Real estate value

FATCA compliance penalties: Failure to comply with FATCA can result in costly financial penalties. The IRS may impose $10,000 penalties per filing violation and a $50,000 penalty for repeat failures. The IRS may also impose a 40% penalty on undisclosed foreign assets if these are understated in tax filings.

Foreign Account Tax Compliance Act Criticism

As a major tax regulation that affects every US citizen, FATCA has faced fierce criticism. Critics argue that the Act imposes needlessly complex administrative burdens on expats and immigrant American citizens, and, consequently, costs more in implementation than the tax revenue that it generates. Recent studies suggest that only 2% of US expats report their foreign-held accounts. 

Beyond its administrative burden, the information gathering requirements that FATCA imposes on foreign financial institutions has been characterized as potentially damaging to international relations. In 2020, FATCA was challenged on privacy grounds with a US-born British citizen objecting to their bank sharing personal account information with the IRS. The complaint was subsequently rejected by UK courts.

Stay FATCA Compliant

>Our Solutions Will Help You Remain Compliant With The Most Up-To-Date AML/CTF Regulations.

Request a Demo

Originally published July 1, 2014, updated May 26, 2022

Disclaimer: This is for general information only. The information presented does not constitute legal advice. ComplyAdvantage accepts no responsibility for any information contained herein and disclaims and excludes any liability in respect of the contents or for action taken based on this information.

Copyright © 2023 IVXS UK Limited (trading as ComplyAdvantage).